In 1999, in the wake of the failure of Massachusetts’s largest HMO and litigation that sought to hold the HMO’s auditors entirely liable for the failure even though others were clearly at fault, the Massachusetts Society of CPAs lobbied for legislation that would abolish joint and several liability as to auditors. Legislation was introduced, the stated purpose of which was to replace joint and several liability for accountants with proportionate liability. Early versions of the legislation would have clearly effectuated this goal. As the bill made its way through the legislative process, however, it was significantly scaled back, to the point where it only limited joint and several liability in cases against public accountants involving claims of fraud against the plaintiff or some other person. The relevant portion of the statute states thus:
When an individual or firm licensed to practice public accountancy . . . is held liable for damages in a civil action arising from or related to its provision of services involving the practice of public accountancy, in which action a claim or defense of fraud is raised against the plaintiff or another party, individual or entity, and that plaintiff or other party, individual, or entity has been found to have acted fraudulently in the pending action or in another action or proceeding involving similar parties, individuals, entities and claims, and the fraud was related to the performance of the duties of the individual or firm licensed to practice public accountancy, the trier of fact shall determine: (a) the total amount of the plaintiff's damages, (b) the percentage of fault attributable to the fraudulent conduct of the plaintiff or other party, individual or entity contributing to the plaintiff’s damages, and (c) the percentage of fault of the individual or firm in the practice of public accountancy in contributing to the plaintiff’s damages. Under the circumstances set forth in this section, individuals or firms in the practice of public accountancy shall not be required to pay damages in an amount greater than the percentage of fault attributable only to their services as so determined. . . .
Mass. Gen Laws ch. 112, § 87A¾.
Until now, there have not been any case law developments or applications of the statute.
In Pari Delicto
In pari delicto is a centuries-old common-law doctrine. While the doctrine has had various applications, including originally in the prohibition on enforcement of illegal contracts, it is commonly used in auditor liability cases. Essentially, the doctrine provides that a company engaged in fraud cannot blame its auditor for negligently failing to uncover its fraud.
In a prior case from 2018, Merrimack College v. KPMG LLP, the Massachusetts high court, in an opinion authored by Chief Justice Gants, addressed in pari delicto. 480 Mass. 614 (Mass. 2018). The court there ruled that the doctrine bars recovery by a company against its auditor for negligent failure to detect fraud at the company, although the court limited the doctrine to apply only where the fraud is perpetrated by “senior management.” Id. at 615. At the end of the 2018 opinion, the court suggested that even though the doctrine was not raised or at issue, the Massachusetts legislature might have repealed and replaced in pari delicto with enactment of the 2001 statute.
Abolishing In Pari Delicto
On July 9, 2019, the Massachusetts Supreme Judicial Court issued its decision in Chelsea Housing Authority. The case involved a claim against an auditor for negligently failing to catch fraudulent overpayment of wages by the executive director of a public housing authority. The trial court had granted summary judgment for the auditors under the in pari delicto doctrine as it was undisputed that the most senior officer of the entity directed the fraud. The Massachusetts high court reversed, in another opinion authored by Chief Justice Gants. The court held that the 2001 Massachusetts statute limiting auditor joint and several liability in fraud cases “preempted” the common law in pari delicto doctrine as to auditors. 482 Mass. at 595.
The court acknowledged that the common law is only repealed by statute if the intent to repeal is clearly expressed. The court then observed that there are no words in the statute expressing any repeal of in pari delicto, nor is there reason to believe that the legislature considered or even knew of the in pari delicto doctrine when it enacted the statute. Nevertheless, the court held that the statute repeals in pari delicto by “necessary implication” because the statute “cannot coexist in harmony with the common-law doctrine of in pari delicto.” Id. at 593. Here, the court reasoned that if auditors could invoke the full defense of in pari delicto in cases of fraud, then the statute would be rendered superfluous.
The court noted in a footnote that there are instances in which in pari delicto and the statute could exist side by side without conflict, as in the Merrimack case, where the auditor failed to detect company fraud but where in pari delicto would not apply because of the limited imputation rules set down by the court in that case. The court stated, however, that such coexistence does not affect its preemption analysis.
The court also stated that notwithstanding that the legislation was admittedly intended to protect auditors from the reach of joint and several liability, it is nevertheless “reasonable to infer” that the legislature had the Enron corporate fraud in mind and thus intended not only to shield auditors from joint and several liability but also to hold them accountable for negligently failing to detect financial fraud committed by their clients. Id. at 590. To reach this conclusion, the court took the unusual step of citing to newspaper articles from the Boston Globe. Notwithstanding that the legislature never indicated anything of the sort, the Massachusetts high court has given the legislation that retroactive intent; thus, with its decision, the court abolishes in pari delicto as to auditors.
With this decision, the Massachusetts Supreme Judicial Court has changed the landscape for liability of accountants and accounting firms in Massachusetts, and for assessing the risks associated with audit engagements governed by Massachusetts law. It remains to be seen whether the Massachusetts legislature might intervene and reinstate in pari delicto as a defense. In the meantime, however, auditors should reassess the pricing and terms on which they will audit financial statements in Massachusetts, and counsel defending malpractice claims should consider how to use the 2001 statute to their advantage when the auditor’s client or others engage in fraud that impacts the audit. Defense counsel should also strive to educate the courts on auditor responsibility, as there was some measure of misunderstanding of this fundamental issue that apparently animated both decisions.
Lisa C. Wood and Matthew C. Baltay are litigation partners at Foley Hoag LLP in Boston, Massachusetts.